BACKGROUND The Foreign Exchange Management Act, 1999 (“FEMA”) and Rules and Regulations issued thereunder came into force from 1st June, 2000. Since then, over last 16 years, they have undergone several changes.
Beginning December 2015, RBI is issuing Revised Notifications in substitution of the original Notifications issued on May 3, 2000. Previously, annually on July 1, RBI was issuing Master Circulars with shelf life of one year. In another change, from January 1, 2016, most of the Master Circulars have been discontinued and substituted with Master Directions (except in case of – Foreign Investment in India and Risk Management and Inter-Bank Dealings). Unlike the Master Circulars, the Master Directions will be updated on an ongoing basis, as and when any new Circular / Notification is issued. However, in case of any conflict between the relevant Notification and the Master Direction, the relevant Notification will prevail.
CONCEPT AND SCOPE
The issues relating to write-off of investments in overseas subsidiary / joint venture entity and some other issues connected therewith are being discussed in this article.
OVERSEAS DIRECT INVESTMENT
Vide Notification No. FEMA 120/RB-2004 dated July 7, 2004, RBI notified the revised Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004. This Notification repealed and substituted Notification No FEMA 19/2000-RB dated 3rd May 2000 which had notified Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2000.
The purpose of this Notification is to regulate acquisition and transfer of a foreign security by a person resident in India i.e. investment (or financial commitment) by Indian entities in overseas joint ventures and / or wholly owned subsidiaries. This Notification also regulates investment by a person resident in India in shares and securities issued outside India. Updated provisions in this regard are contained in FED Master Direction No. 15/2015-16.
This article discusses the following aspects in the context of overseas investment made by an Indian party in the shares of an overseas entity.
1. Restructuring of the balance sheet of the overseas entity involving write off of capital and receivables.
2. Sale of shares in a WOS / JV involving write off of the investment (or financial commitment).
1. Restructuring of the balance sheet of the overseas entity involving write off of capital and receivables
Almost all businesses suffer teething troubles and have a gestation period during which it will generally incur losses. However, over time, the business comes on track and also recoups the initial losses. Indeed, in some cases it may happen that despite the best efforts of the Indian party, the business continues to suffer losses and may require restructuring. Such instances are increasingly noticed in the post-2008 period which is marked by global economic turmoil.
If appropriate corrective action is not taken at the appropriate time, it may not only affect the viability and continuity of the business but the overseas entity may become sick and be in an irrecoverable situation although the business may have good potential. In such cases, the possible solution could be to restructure the balance sheet of the overseas entity by setting-off the past losses against the paid-up capital and reserves. However, this would also require the shareholders to write down their investment in the overseas entity.
In this background, in 2011 RBI amended Notification No. FEMA 120/RB-2004 and inserted Regulation 16A which permits the Indian Party (investors / promoters) to undertake restructuring of the overseas entity. Regulation 16A permits write-off of investment as well as receivables subject to compliance with certain conditions.
Such write off is permitted in case of both Wholly Owned Subsidiary (WOS) of the Indian Party or a Joint Venture (JV) of the Indian Party along with overseas investor(s). However, in case of a JV, the write-off is permitted only if the Indian Party holds at least 51% stake in the JV.
What can be written-off
The Indian Party can write-off the following investments / dues from the foreign entity: –
1. Equity share capital.
2. Preference share capital.
3. Loans given.
4. Royalty
5. Technical knowhow fees.
6. Management fees.
Available Routes for restructuring and write-off
This restructuring and write-off can be done either under the Automatic Route or under the Approval Route. The maximum amount that can be written-off under the Automatic Route as well as the Approval Route is 25% of the equity investment made by the Indian Party in the overseas WOS / JV.
AUTOMATIC ROUTE
A company listed on a recognised stock exchange in India can avail of the Automatic Route. The Indian Party is required to report the write-off / restructuring to RBI, through the designated AD Category-I Bank within 30 days of the write-off/restructuring.
APPROVAL ROUTE
An unlisted Indian Party can write-off / restructure its investment / receivables in overseas WOS / JV only after obtaining prior approval of RBI. It will need to apply to RBI, through the designated AD Category-I Bank.
Documents to be submitted
Both under the Automatic Route as well as the Approval Route, the Indian Party is required to submit the following documents together with its application.
a) A certified copy of the balance sheet showing the loss in the overseas WOS/JV set up by the Indian Party.
b) Projections for the next five years indicating benefit accruing to the Indian company consequent to such write off / restructuring.
2. Sale of shares in a WOS/JV involving write off of the investment (or financial commitment)
Depending upon the business exigencies, an Indian Party may consider selling its shares in the overseas WOS / JV. Regulation 16(1) grants general permission to an Indian Party to disinvest the shares subject to certain conditions if the sale does not result in any loss.
However, it is not necessary that the sale will always result in profit. Hence, RBI has granted general permission for disinvestment of shares by an Indian Party where such disinvestment results in a loss. It may be noted that the computation of ‘loss’ in case of Notification No. FEMA 120/RB-2004 is distinct from that the computation of ‘loss’ in terms of the Income-tax Act, 1961. For FEMA purpose, the ‘loss’ is to be understood as realisation of disinvestment proceeds of shares which are less than the investment made. Thus, there would be a ‘loss’ when the disinvestment proceeds on the sale of shares are lower than the amount paid at the time of purchase of shares.
Again, disinvestment by an Indian Party in its overseas WOS / JV, resulting in a loss or write-off on investment, can be either under the Automatic Route or the Approval Route.
AUTOMATIC ROUTE
The Indian Party can avail the Automatic Route if it complies with any of the following four criteria.
1. The overseas JV / WOS is listed on a stock exchange outside India.
2. The Indian Party is listed on a stock exchange in India and it has net worth of not less than Rs. 100 crores.
3. The Indian Party is listed on a stock exchange in India, it has net worth of less than Rs. 100 crores but investment in the overseas JV / WOS does not exceed US $ 10 million.
4. The Indian Party is unlisted and the investment in the overseas entity does not exceed US $ 10 million.
Once the Indian Party qualifies under any of the aforementioned criteria, it will need to comply with the following conditions.
a. If the shares of the overseas JV / WOS are listed, the sale should be effected through the stock exchange.
b. If the shares of the overseas JV / WOS are not listed and they are disinvested by a private arrangement, the share price should not be less than the value certified by a Chartered Accountant / Certified Public Accountant as the fair value of the shares based on the latest audited financial statements of the JV / WOS.
c. The Indian Party should not have any outstanding dues by way of dividend, technical know-how fees, royalty, consultancy, commission or other entitlements and / or export proceeds from the JV or WOS.
d. The overseas concern should have been in operation for at least one full year and the Annual Performance Report together with the audited accounts for that year must have been submitted to RBI.
e. The Indian Party is not under investigation by CBI / DoE/ SEBI / IRDA or any other regulatory authority in India.
f. The Indian Party should submit details of such disinvestment through its Bank in Part III of Form ODI within 30 days from the date of disinvestment.
g. Sale proceeds should be repatriated to India within 90 days from the date of sale of the shares / securities.
APPROVAL ROUTE
If an Indian Party does not satisfy the criteria / conditions mentioned above, it should obtain prior approval from RBI for undertaking divestment in its overseas WOS / JV.
SPECIFIC WINDOW IN CASE OF A LISTED COMPANY HAVING EXPORTS
In addition, Regulation 171 provides another window for write-off in case of a listed company. Thus, if the proceeds realised by an Indian Party listed on any stock exchange in India from sale of shares or security referred to in Regulation 16 (1)2 are less than the amount invested in the shares or security transferred, the Indian Party may write off the differential amount if such differential amount does not exceed the percentage approved by the RBI, from time to time, of the Indian Party’s actual export realization of the previous year.
If, however, the differential amount is more than the percentage approved by RBI from time to time, of the Indian Party’s actual export realisation of the previous year, prior permission of RBI would be required for write-off.
SIGNING OFF
As pointed out above, transfer by way of sale of shares of a JV / WOS outside India as well as restructuring of the balance sheet of JV/WOS involving write-off of capital and receivables, requires fulfillment of various conditions and also involves various compliances. It would be prudent to examine the facts carefully and in appropriate cases, wherever applicable, apply to the RBI for permission which may be granted subject to such conditions as the RBI may consider appropriate.
1 It may be noted that while Notification No. FEMA 120/RB-2004 includes Regulation 17, Master Direction No. 15/2015-16 on investment in JV/WOS does not make any mention thereof.
2 While Regulation 17 mentions Regulation 16(1), it also mentions “for a price less than the amount invested in the shares or security transferred”. A case where sale proceeds are less than investment is within the ambit of Regulation 16(1A) and not within the ambit of Regulation 16(1). Hence, Regulation 16(1) should be read as Regulation 16(1A).
